State Aid for R&D

The eligible costs amount to EUR 1.503 billion out of which EUR 1.314 billion are eligible for aid in France while EUR 189 million are eligible for aid in Germany.

The aid given by France is in the form of a repayable advance. Once the principal and the interest on the advance are repaid, Airbus will continue to pay to France royalties calculated on the basis of the revenue from sales of X6 helicopters and spare parts. The interest is calculated according to the 2008 Commission Communication on reference rates. The payment period will cover the lifespan of the X6 project. The aid measure fixes in advance a progressively higher amount of payment per helicopter. This also means that if sales fall below their expected level, the amount paid will be correspondingly lower.

The amount of the repayable advance is EUR 330 million. It will not be granted as a lump-sum but rather in instalments as the project progresses.

The funding provided by Germany takes the form of a loan of EUR 15.27 million, on market terms, combined with a repayable advance of EUR 47.25 million. The interest rate for the loan is also calculated according to the 2008 Commission Communication on reference rates. The repayable advance is also granted on similar terms to those of France.

The total amount of aid is EUR 393 million [≈ 330 + 15.3 + 47.3]. The aid amounts and intensities for the various parts of the project are as follows:

• EUR 82 million for industrial research corresponding to aid intensity of 35.3%.
• EUR 295.25 million for experimental development [repayable advances] corresponding to aid intensity of 23.2%.
• EUR 15.27 million for experimental development [market-conform loan].

Presence of State aid

There was no doubt that the repayable advances were State aid. However, the Commission agreed with Germany that no State aid was included in the loan of EUR 15.27 million because it would be granted at a rate of interest that was calculated on the basis of the 2008 Communication on reference rates. The Commission referred at this point to its decisional practice and cited decision SA.23600 concerning the financing arrangements for Munich Airport Terminal 2 [October 2013].

Compatibility with the RDI Framework

In order to determine the compatibility of the aid with the internal market the Commission applied the principles laid down in the RDI Framework.

Contribution to a well-defined objective of common interest

Although it is fairly easy for Member States to demonstrate that RDI aid promotes the common interest, France and Germany submitted information that showed that:

The scope of the project would be wider with the aid. RDI spending by Airbus would increase as would the number of skilled employees assigned to the aided activities.

Because several parts of the text of the Commission decision are redacted or deleted for being business secrets, the decision does not indicate how Airbus proved that the aid would lead to wider project scope and increased expenditure.

Paragraph 69 of the decision states the following:

“Airbus Helicopters is the only European helicopter manufacturer present in the heavy-duty helicopter segment of the market. In accordance with point 47 of the R&D&I Framework, the French and German authorities explained that, […]. The Commission can conclude that, by allowing Airbus to develop a new innovative product on this specific segment of the market, the aid will therefore contribute to the overall increase of R&D&I spending in the aeronautic sector, […].”

Point 47 of the RDI Framework provides that:

“In order to conclude that the aid contributes to increasing the level of R&D&I in the Union, the Commission will consider not only the net increase of R&D&I carried out by the undertaking, but also the contribution of the aid to the overall increase of R&D&I spending in the sector concerned, as well as to the improvement of the Union situation with regard to R&D&I in the international context.”

It is rather obvious that if there is only one company in Europe making a certain product, an increase in its R&D automatically translates into an increase in EU R&D. But while the unique position of Airbus for heavy-duty helicopters makes it rather easy to show a simultaneous increase in EU-wide RDI spending, it also casts doubt on how risky the project is and, therefore, on the need for aid. A company that spends money on RDI runs several risks: research or technological risk [that it would not find anything useful], financial risk [that it would incur unforeseen costs or that the cost of capital would increase], commercial risk [that the eventual product would not generate sufficient sales or that competitors would undercut it] and loss of knowledge risk [that competitors would be able to copy its technology or poach its researchers]. It is unlikely that a dominant company in Europe would have its personnel poached by American, Russian or Chinese competitors.

Need for state intervention

Not surprisingly France and Germany highlighted the technological and commercial risks of the project. With respect to commercial risks, it was noted that Airbus embarked on the project without any confirmed potential customers [this is commercial risk].

The Commission also examined possible financial constraints and limited access to finance caused by the long amortisation period which stretches to 20-30 years and the very specific risks of the project, which investors could not diversify away.

In addition to the market failures that affected the project, the Commission took into account positive externalities from the project. The decision mentions improved environmental footprint and advanced safety standards.

Two comments are in order in connection to the claimed positive externalities. First, there is no indication about the size of those benefits and how the aid directly impacts on higher environmental and safety standards or how such standards could not be realised without the aid. Some new technologies, by their very nature, are intrinsically linked to higher safety and environmental standards. The aid, therefore, is unnecessary for inducing higher standards.

Second and more generally, the fact that a new product benefits society at large does not necessarily mean that the producer would not be willing to make it without the aid. A helicopter which is safer to operate is likely to attract more customers and command a higher market price. In other words, it is more appropriate to distinguish between the benefits which are inherent in a new product and the extra benefits which are induced by the aid. However, in the particular case, as will be seen below, Airbus did not consider any alternative to the aided project. All benefits could be attributed to the project.

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 Appropriateness of the aid measure

The Commission acknowledged that the aid addressed the identified market failures. The repayable advances allowed the risk inherent in production of the X6 helicopter to be shared with the state, in view of the fact that the market was not willing to bear that risk. The funding through repayable advances also ensured a financial return to the state in case of success.

France and Germany argued that no other means of intervention would achieve the same result without causing a larger distortion of competition. Regulatory intervention to impose higher standards was not appropriate because of the technological uncertainties. Fiscal measures of general scope in favour of R&D would encourage research but would not necessarily lead to risk-sharing for long-term projects. Similarly, a straight loan would not in any way reduce the risk to Airbus Helicopters.

The Commission agreed that repayable advances were an appropriate instrument to finance an R&D project with a large amount of initial investment, high technological and commercial risk and long period of amortization. In addition, this type of instrument did not provide an excessive advantage to the company in case of success because the state would be fully reimbursed, with interest and royalties, after the advances would be repaid.

Incentive effect

As is required of all aid in any sector and for any purpose, the Commission verified that the project had not started before the application for the aid was submitted.

Counterfactual analysis

The alternatives to the X6 project were either an upgrade to an existing model or a downgraded version of the X6. Because neither option was attractive enough in terms of potential sales, the counterfactual scenario was no project at all.

In paragraph 115, the decision states that “the Commission considers that the counterfactual analysis provided by the French and German authorities is not informative about the incentive effect of the aid measure. A specific counterfactual project can only be considered if it is clearly proven that the aid recipient considered the counterfactual project as a mutually exclusive credible alternative investment for the aided project.” “(116) The Commission therefore assessed whether the incentive effect of the aid measure by comparing the estimated WACC of the project with the estimated IRR of project, with and without aid. In doing so, the very particular circumstances of the X6 project were taken into consideration (high number of very innovative work-streams each involving specific risks, particularly high upfront expenses and specificities associated with the commercial risks due to the demand segment targeted by the project).

Analysis of the incentive effect

Although the most interesting information and numbers have been deleted for being business secrets, one can still identify elements that had decisive influence on the Commission’s assessment.

France and Germany provided information [not disclosed] about the internal hurdle rates of Airbus [i.e. the rate of return that a project should achieve in order to be approved by the management]. But according to the Commission, “(118) in this particular case the internal hurdle rate of the beneficiary […] is not sufficiently informative for the assessment of the incentive effect. An internal document advising the various entities of the group to pursue projects with hurdle rates ranging from the company WACC up to a certain level (in this case, […]%) cannot be used as evidence that high hurdle rates are the norm in a given firm.” “(119) Furthermore, the […]% hurdle rate was applied to Airbus Group as a whole and not to individual divisions or helicopter projects.” “(120) Absent a clearly defined counterfactual project […] that the aid recipient would demonstrably consider carrying out absent the aid, the incentive effect of an aid measure can be assessed by comparing the WACC with the expected IRR of the aided project, with and without aid.”

“(121) For the assessment of the incentive effect, the company WACC is the right benchmark to compare the aided project’s IRR against, only if the aided project is exposed to the same risks as the company as whole. However, for reasons explained above […], the Commission considers that the X6 project is highly atypical for Airbus Helicopters and Airbus as a whole.” “(122) The cost of capital (WACC) is normally higher for projects with higher risk. The German and the French authorities explain that the X6 project is not a typical project for Airbus Group due to the especially high risks it involves. The commercial risk of the X6 project, which has a strong non-diversifiable component, seems to be particularly high. The project seems to be strongly dependent on the overall economic growth and the general business cycle in view of the specific segment of demand (oil and gas) that it mostly targets.”

“(125) The non-diversifiable part of the risk (captured in the beta) would lead investors to ask for a higher risk premium and therefore increases the WACC. The Commission considers that a WACC of around […]% can be seen a reasonable proxy for the cost of capital of the X6 project. […] Such high betas seem to be typical for the oil and gas production, distribution and equipment industries in Europe. These industries carry particular relevance for the X6 project, as evidenced by the strong correlation between oil prices and demand for large and super medium helicopters […]. Estimates for betas are not available for the helicopter industry and given the specific risk of the project, it is very likely that an aggregate industry beta would not be representative for this project in any case.”

The Commission then compared its benchmark WACC with the derived IRR. The business plan showed that “(126) the repayable advance of EUR 377 million increases the internal rate of return of the X6 project from […]% (probability weighted) to […]% (probability weighted). The return of […]% is only slightly higher than the presumed […]% cost of capital of the project. Therefore the Commission considers that the aid provides the required incentive effect.” #

Proportionality of the aid

The research activities that were to be carried out in the project fell within the categories of “industrial research” and “experimental development”. These two research categories may receive aid with intensity up to a maximum of 50% and 25% respectively for a large company such as Airbus Helicopters. Aid amounting to EUR 82 million would be granted for industrial research activities, i.e. with an aid intensity of 35%. Aid amounting to EUR 248 million would be granted for experimental development, i.e. with an aid intensity of 23%. Given that the aid would be granted in the form of a repayable advance, according to the RDI Framework, Airbus Helicopters could legally receive an additional 10 percentage points of aid. Consequently, the Commission concluded that the aid would be limited to the minimum necessary.

Avoidance of undue negative effects on competition and trade

The Commission considered it appropriate to distinguish between the military helicopter market and the civil helicopter market because the two types of aircraft did not meet the same needs and did not have the same characteristics. Although the Commission naturally focused on civilian market, it did not think it necessary to “(135) further delineate the relevant product markets for civil helicopters by reference for instance to technical criteria, such as mission type or maximum take-off weight. This line was followed in State aid decisions relating to this sector.” This is odd because the X6 would have a very specific mission. As indicated above, the Commission did take its mission into account in determining the riskiness of the project and its WACC.

The Commission found that the market was characterised by a strong supply-side substitutability and market segments with very fluid boundaries. Demand was expected to grow significantly. On the supply side, there were five main worldwide helicopter manufacturers: two European (Airbus Helicopters and Leonardo), two American (Bell and Sikorsky) and one Russian (Russian Helicopters). There were also manufacturers from emerging countries (such as the Indian HAL, the Chinese Avicopter, the Korean KAI). Airbus had a market share of 35-40%, Leonardo 15-20%, Bell 15-20%, Sikorsky 5-10-% and Russian Helicopters 5-10%.

In the heavy helicopter segment, Russian Helicopters have a larger market share but historically they have had a “very low market share in the offshore oil and gas segment”.

Impact of aid on the markets

RDI aid can potentially distort competition by (a) distorting dynamic incentives, (b) creating or maintaining market power and (c) maintaining inefficient market structures.

Distorting dynamic incentives

A seriously negative effect of R&D aid is the potential of “crowding out” of private effort; i.e. aided-research overwhelms non-aided research. The Commission used the following indicators to determine whether there was any crowding out:

• The aid amount was relatively small: The aid was in the form of repayable advances while the aid amount was not large in relation to the overall amount of R&D expenditure in the aviation industry. The aid was not liable to discourage competing companies from continuing their R&D efforts. [Although the amount of aid and R&D expenditures could be objectively measured, it was not clear how the Commission concluded that competitors would not be discouraged.]
• The market was expected to grow: Consequently, there would be opportunities for competitors to develop profitable business. As the X6 was expected to achieve a [15-35]% market share, the Commission considered that there would remain “ample opportunities for competitors to develop their business” in a market with “high growth prospects”. [This raises two questions. First, were the competitors also expected to receive aid? If they were not, then how could they develop competing helicopters while for Airbus the project was deemed to be too risky? Second, if the market was characterised with high growth prospects, then the commercial risk of the project was not as high as claimed earlier in the assessment.]
• High exit barriers: The obstacles to leaving the aviation industry were thought to be “very high” due to “irrecoverable costs” and “the high intensity of capital in this industry, which required very large upfront investments in R&D projects and highly specialised technical engineering equipment”. The Commission concluded that the aid would not dissuade market players from continuing to innovate and that there were strong incentives to compete for a future market. [Again, what prevented Airbus from also competing without aid?]
• Product differentiation and intensity of competition: The aided project would motivate other competitors to innovate in R&D. It was expected that “the main competitors of Airbus Helicopters (particularly Sikorsky and Russian Helicopters) will offer new models in the same market in the near future. Consumers will have more choice with the expansion of the range of helicopters offered.” [Once more, this suggests that somehow the high risk of this project did not deter competitors. The decision is silent on whether they had access to State aid.]

Creating or maintaining market power

The Commission verified whether the aid could strengthen the market power of Airbus (capacity to influence prices, production, variety or quality of goods) to the detriment of consumers.

• Market power: The heavy-duty helicopter segment is oligopolistic. But Airbus is expected to continue to face intense competition.
• Entry barriers: The barriers to entry (technological, financial and regulatory) are thought to be very large. [It is not clear how this finding impacted on the Commission’s decision.]
• Buyer power: The Commission noted that helicopter manufacturers had to anticipate the needs of their customers who were large, sophisticated companies, with buyer power. The presence of strong buyers would preserve sufficient competition in the market.

The Commission concluded that the aid to the X6 project would not strengthen the market power of Airbus.

Maintaining inefficient market structures

The RDI Framework does not favour aid in markets with overcapacity or to declining industries. Since the market of civil helicopters was expected to experience strong expansion, the market was not suffering from overcapacity, nor did it constitute an industry in decline.

Comments

The overall conclusion of the Commission was that the aid met all the requirements of the RDI Framework and therefore was compatible with the internal market.

Yet, there appears a tension and perhaps an underlying contradiction between the reasoning for the need of aid and the reasoning that the aid would not cause an undue distortion to competition. If competitors would remain active and would be able to compete with Airbus, would Airbus not have a very strong incentive to develop a rival model so as not to be edged out of the market? And, if yes, was the risk so high as presented in the part of the decision that justified the need for state intervention? The Commission accepted that Airbus would not have developed an alternative model. But that appears to be at odds with the analysis of how the civilian helicopter market, in general, and the heavy-duty helicopter market, in particular, would evolve.

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^[1] The full text of the Commission decision can be accessed at:

http://ec.europa.eu/competition/state_aid/cases/269252/269252_1956614_87_2.pdf.